Executive Summary
Stock research essentially involves arriving at precise inferences on particular securities’ worth, based on the gathered legitimate information and the subsequent release of this information to investors. However, investment banks have an incentive to trade by buying undervalued stocks and selling highly-priced ones against the instructions of the retail investors thereby earning a considerable profit. In his article, Citigroup banks on a reform plan, Thor Valdmanis, holds the opinion that incentives do not work but favors reforms involving the separation of investment banking from stock research as a way of limiting the flow of information between the two groups to prevent conflict analyst policies.
However, incentives can work if well regulated by an oversight board that oversees stock research and distribution of the findings thereafter. Also, cutting down the incentives, as the author seems to suggest, will result in fewer wages for the analysts. This will, in turn, affect information-generating interactions, as fewer good individuals will be attracted to stock research. The quality of research is likely to drop and consequently harm investors.
Policy Considerations
The issue of conflict of interest over institutional arrangement in investment banks calls for policy solutions for the settlement of analyst conflicts. Valdmanis (2002) agrees to the fact that an oversight body to regulate the operations of the investment banks like the Wall Street stock research is good. However, the author goes ahead to point out that this move will harm investors in the end. The author further argues that the investment banks are left with no option but to sign the reform plan as a way of resolving past misconduct in the investment-banking business.
For instance, Merrill Lynch agreed to pay a fine of $100 million after claims that analysts had exaggerated stocks to secure investment-banking deals. This is just but an example of what might happen if funds research is not regulated properly. However, considering that investment banks are profit-maximizing entities, it will be appropriate to leave them to develop an internal mechanism to handles such matters instead of an oversight regulatory body. This move would foster the autonomy of the different investment banks, a step that would enhance competition hence a healthy business environment.
Moreover, the industry will incur over $ 1 billion in the next five years to keep the new oversight board running in its task of regulating Wall Street research coupled with advancing and disseminating information from other independent firms that offer no services in investment banking. This move is expensive; moreover, pushing Wall Street out of research would affect the quality of the stock analysis. Also, the inevitable high costs and regulation policies accompanying this move would lockout start-up companies from accessing public funding. Therefore, in light of these policy considerations, the move to form an oversight body to run research is not only expensive but also dangerous.
The management board of a firm can design the budget for its stock research department not based on revenue generated from investment banking. Also, investment bankers should not evaluate the job performance of the research analysts, as this will cause a conflict of interest (Rosenbaum, J., & Joshua, P., 2009, p.133). There should be a requirement for the investment bank to disclose necessary information regarding the analysts’ historical background before making decisions to invest.
Policies to ensure proper dissemination of investment information to individual investors will serve to reduce the conflict of interest. Firewalls that act as an information barrier to restrict interaction between banking and research will lead to more objective stock analysis. Such a move would enhance efforts to group jobs into subunits for effectiveness and increased productivity. Grouping jobs into subunits underlines the core very principle of job specialization, which seeks to improve efficiency and production.
Valdmanis supports the agreement to establish an oversight board reached during the Citigroup’s’ conference whose role will primarily involve regulation of Wall Street research and promote the dissemination of research by independent firms to prevent biased analyst recommendations. In light of the $100 million research settlement paid by Merrill Lynch, it is apparent that the market understands and corrects this bias. Also, analysts of large investment banks appear to be less biased and more precise in their recommendations than their counterparts who work for independent research firms (Rosenbaum & Joshua, 2009, p.134).
This evidence means that oversight regulators have a limited basis for the proposal to separate investment banking from research as a way to protect investors. Separating stock research from investment banking will lead to a limitation in the scope of research and make other information from banks inaccessible to the research analysts. This will affect the quality and accuracy of research leading to a decline in the wages of the analysts.
Conclusion
Despite the evidence that investment banking that also deals with Stock research leads to a conflict of interest, as Valdmanis puts it in his article, Citigroup banks on a reform plan, the stock market prices adjust to correct the biases brought about by analysts’ recommendations. The separation of investment banking from stock research in itself cannot warrant the protection of retailer investors. Other policy considerations apply to the achievement of protection of investors from biased analyst recommendations.
Reference List
Rosenbaum, J., & Joshua, P. (2009). Investment Banking: Valuation, Leveraged Buyouts, Mergers, and acquisitions. New Jersey: John Wiley & Sons.
Valdmanis, T. (2002, Oct. 31). Citigroup banks on reform plan. USA Today.